US sanctions on Iran could add $50 to global oil prices

The oil industry might not be able to produce enough oil to meet global demand in a few years’ time, setting markets up for a serious price spike.

To be sure, much of the oil world is focused on the supply fears in the near-term. The outages in several OPEC nations, plus the tightening noose on Iran from the US government, could lead to a supply shortfall towards the end of this year, a hole so big that Saudi Arabia could struggle to fill it, even if it burned through much of its spare capacity.

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But over the long-term, there are also questions about the global oil industry’s ability to supply enough oil to the market.

It isn’t the same “peak oil” theory as yesteryear, but there certainly seem to be echoes of that argument bubbling up the surface once again. While the world isn’t running out of oil, there could be a shortage of cheap oil by the early part of the next decade. The majors have cut spending on exploration and development so drastically that there will be a dearth of new large-scale projects coming online in the next few years.

And the new hyper-focus on profitability at the expense of growth, a mantra pressed upon oil companies by restive shareholders, could keep supply constrained.

The IEA has repeatedly warned over the past few years that US shale growth would likely plateau in the 2020s, which means that the world would be right back to where it started – dependent on oil-producing nations in the Middle East.

There are some shale boosters that see nothing but sunny days ahead for US shale, but a lot of other market watchers see shale flattening out in the next decade before entering into an extended period of decline. After that, as the IEA has argued, the Middle East will once again be the supplier of last resort.

The problem is that the supply crunch might be so severe that Saudi Arabia won’t be able to come to the rescue.

“Something like shale oil…it is not going to really create a major dent in total global supply requirements up until 2040,” Saudi Aramco’s CEO Amin Nasser said in an interview with the Financial Times. “Everybody needs to do his share…We will contribute, but how much we will contribute?” he said, a recognition that Saudi Arabia won’t be able to do it alone.

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US shale growth over the past decade has been so explosive that it helped crash oil prices in 2014. But the supply surge masks “chronic underinvestment,” Sanford C. Bernstein & Co. analysts wrote in a note last week. The investment manager said the newfound focus on profitability, which has led a long list of oil and gas companies to deprioritize growth, could create the conditions for a major supply crisis.

“Investors who had egged on management teams to reign in capex and return cash will lament the underinvestment in the industry,” the analysts wrote. “Any shortfall in supply will result in a super-spike in prices, potentially much larger than the $ 150 a barrel spike witnessed in 2008.”

Of course, for many, this is a problem for another day. The oil market is arguably facing a supply crisis right now. Until recently, the oil market assumed a loss of about 0.5 mb/d from Iran because of US sanctions. But statements from the US government about “zero tolerance” towards Iran could mean that those losses will end up being much higher. Just by shifting the supply outages from 0.5 to 1 mb/d would translate into an oil price increase of about $ 8 to $ 9 per barrel, according to Bank of America Merrill Lynch.

“We estimate that every million b/d shift in [supply and demand] balances would push the oil price by $ 17/bbl on average. So based on those assumptions, we estimate zero Iran exports could push oil up by $ 50/bbl if Saudi caps out. We expect in this game of chicken, someone will blink before that happens.”

In other words, if Saudi Arabia is unable to plug the deficit, the US would likely have to back down on its “zero tolerance” policy towards Iran. The oil market is too tight, and the supply gap would be too large. Cutting Iran exports by that much, in an increasingly tight oil market, would send prices skyrocketing, something that the Trump administration probably won’t be able to stomach. If Trump proceeded, a price spike of that magnitude would lead to a meltdown in demand.